Q&A: The confusing balancing act between government pensions and Social Security benefits

Dear Liz: I am a public school teacher and plan to retire with 25 years of service. I had previously worked and paid into Social Security for about 20 years. My spouse has paid into Social Security for over 30 years. Will I be penalized because I have not paid Social Security taxes while I’ve been teaching? Should my wife die before me, will I get survivor benefits, or will the windfall elimination act take that away? It’s so confusing!

Answer: It is confusing, but you should understand that the rules about windfall elimination (along with a related provision, the government pension offset) are not designed to take away from you a benefit that others get. Rather, the rules are set up so that people who get government pensions — which are typically more generous than Social Security — don’t wind up with significantly more money from Social Security than those who paid into the system their entire working lives.

Here’s how that can happen. Social Security benefits are progressive, which means they’re designed to replace a higher percentage of a lower-earner’s income than that of a higher earner. If you don’t pay into the system for many years — because you’re in a job that provides a government pension instead — your annual earnings for Social Security would be reported as zeros in those years. Social Security is based on your 35 highest-earning years, so all those zeros would make it look like you earned a lower (often much lower) lifetime income than you actually did. Without any adjustments, you would wind up with a bigger check from Social Security than someone who earned the same income in the private sector and paid much more in Social Security taxes. It was that inequity that caused Congress to create the windfall elimination provision several decades ago.

People who earn government pensions also could wind up with significantly more money when a spouse dies. If a couple receives two Social Security checks, the survivor gets the larger of the two when a spouse dies. The household doesn’t continue to receive both checks. Without the government pension offset, someone like you would get both a pension and a full survivor’s check. Again, that could leave you significantly better off than someone who had paid more into the system.

Q&A: Options for a pension payout

Dear Liz: I am a single, 52-year-old female. I just received some information about my pension from a previous employer that gives me the option to take a lump sum of $18,701 that I can roll it into an eligible retirement plan. Or I could also take it now and be subject to penalty and taxes. Or I could defer taking payment until I’m 65, when I would start getting a monthly estimated check worth $218.68. The time is limited to make my decision. I don’t need income now, so I am interested in taking the rollover and severing ties with them. But I could wait until I am 65 and take the monthly payments. Which deal is better financially?

Answer: Theoretically you can do better with the lump sum — assuming you roll it over into an IRA or other retirement plan, invest at least half of it in stocks for long-term growth and keep your hands off the money until you’re ready to retire. If you would be tempted to do something stupid like cash out, then you’re better off with the annuity. The annuity check also is for life, while the fate of the lump sum depends on market returns.

Q&A: Social Security vs. state pension

Dear Liz: I worked enough in private industry to qualify for Social Security benefits, but then worked for the state and did not contribute to Social Security for another 20 years. So, I will have a state pension at my current salary as well as Social Security representing my former salary, which was about one-third of what I’m making now. My question is, would it be of value to retire early and return to private industry for a few years?

Answer: Your Social Security benefit is likely to be reduced because you’re getting a pension from a job that didn’t pay into Social Security. This is known as the windfall elimination provision, and you can learn more about it on the Social Security website.

You can avoid the provision if you had 30 years or more of “substantial earnings” (which varies by year but was at least $22,050 in 2015) from jobs that paid into Social Security.
It probably wouldn’t make much sense to quit a well-paying job with a presumably generous pension to try to boost a much smaller Social Security payout. But a fee-only financial planner could run the numbers for you and explain your various options.

Monday’s need-to-know money news

download (1)Today’s top story: How to put an end to credit card solicitations. Also in the news: How a two checking account system could help automate your budget, how to maximize your pension, and five surprising sources of debt.

How to Stop Credit Card Solicitations for Good
Reclaiming your mailbox.

Use the Two Checking Account System to Automate Your Budget
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Maximize Your Pension With This Calculator
Calculating the best option for your retirement.

5 Surprising Sources of Debt
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Q&A: Public pension and Social Security

Dear Liz: I am one of the thousands of adjunct faculty who teach in our nation’s colleges. We are paid on an hourly or per-class basis. We therefore earn a fraction of what tenured faculty earn. I am covered by a state teachers pension, but my anticipated benefit, even after 30 years of teaching, will not exceed $1,500 per month. I have qualified for a modest Social Security benefit of perhaps $1,000, accrued through years of part-time work as a student and graduate student. I have been told that my Social Security will be reduced because of my teacher’s pension.

Surely this cannot be correct. I understand that if I were collecting a generous state or military pension, I would not need Social Security. However, without my Social Security, my teacher’s pension will not even lift me above the poverty level. Isn’t there some sort of “means testing” before they slash your Social Security benefit?

Answer: You were informed correctly. When you receive a pension from a job that didn’t pay into Social Security, any Social Security benefit you did earn may be reduced (but not eliminated).
Before the creation of the Windfall Elimination Provision, people who received pensions based on earnings not covered by Social Security often got a proportionately larger benefit than those who paid into the system their entire working lives.

The Social Security site has a chart and a calculator to help you understand how your benefit might be affected. The chart shows that if you reached age 62 this year and you had fewer than 20 years of so-called “substantial earnings” covered by Social Security, your monthly benefit could be reduced by up to $413 or half of your teacher’s pension, whichever is less. Limiting the offset to half protects people who get small pensions from having too much of their Social Security benefit wiped out. Substantial earnings are wages equal to or above a certain amount each year ($22,050 for 2015) from jobs that paid into Social Security.

Based on the information you provided, your pension and Social Security income would total just over $2,000 a month. That’s not a lot, but the average Social Security check in 2015 was about $1,300. The poverty threshold in 2015, meanwhile, was $980 per month for a one-person household and $1,327.50 for a two-person household.

Q&A: Pensions and the windfall elimination provision

Dear Liz: As a faculty member who was only recently allowed to participate in our state’s public employees’ retirement system, I will have a very small pension. I’m told that Social Security will then reduce my benefit by up to 50% as a result of the so-called windfall elimination provision. Can you tell me how this is legal?

Answer: Many people affected by Social Security’s windfall elimination provision are outraged that their benefits will be reduced. Before the provision was enacted in 1983, though, people who paid less into the Social Security system wound up getting an outsized benefit.

Here’s why. Social Security is designed to replace more of a worker’s income the less he or she makes, with the understanding that saving for retirement is harder the lower your income.

When you get a pension from an employer who doesn’t pay into the Social Security system, but you also qualify for Social Security benefits from other jobs, your Social Security earnings record can look as if you were a long-term, low-wage worker even when you’re not. Without the windfall elimination provision, you could wind up with a Social Security check that replaces more of your income than you would have received had you only worked in jobs covered by Social Security.

How much your benefit will be reduced depends in part on how many years you worked in those other jobs — the ones that were covered by Social Security. The longer you worked at jobs covered by Social Security, the less the windfall elimination provision affects you, as long as you had “substantial earnings” from those jobs. The amount that’s considered substantial varies by year, ranging from $3,300 in 1974 to $21,750 this year. You’ll experience the maximum 50% reduction if you have 20 or fewer years of substantial earnings. If you have 30 years of such earnings, the provision doesn’t affect you at all.

Q&A: Saving vs Relying on pension

Dear Liz: My husband works for the government and will be receiving a pension when he retires. Am I still supposed to save the recommended amount for retirement from my income or can that amount be reduced since we know we have the pension? We are starting a family and could use any extra money we can get right now.

Answer: If your husband is just a few years away from collecting that pension, counting on it to be there is reasonable. Since you’re just starting a family, though, it’s much more likely that retirement is decades away, and a lot can happen in that time.

Your husband could be laid off or fired, or he could quit. Even if he sticks it out, the government could change the way his pension is accrued to make it less generous. (The rising cost of public employee pensions concerns many lawmakers and taxpayers.) Even if he gets what he expects, his pension may not be enough to support the two of you in old age.

So yes, you should be saving for retirement. A cautious person would save as if no pension existed. Someone who’s comfortable with risk might simply aim to fill the gap between the expected pension and future living costs. Others might find a comfortable saving rate between those two points. You can use AARP’s retirement calculator to help you create a plan that allows you to take care of your family today without depriving yourselves in the future.

Q&A: When to start taking Social Security

Dear Liz: You’ve often talked about delaying the start of Social Security benefits to maximize your check. But what about in the case of a widow? My husband died in 2006 at the age of 57. I will be 62 this year and could start receiving benefits based on his earnings. (I did not work during our marriage as I was a home-schooling mom.) I’ve been living off my husband’s modest pension benefits. Would waiting until full retirement age increase the monthly payment I would ultimately get? One of the reasons I ask is that I have an adult son who lives with me and who probably will never be able to have a job. Yet he is not officially disabled and, as far as I know, is not eligible for any kind of benefits. I wondered if it might be a good idea to start taking Social Security as soon as I could and either save or invest the monthly checks to add to what I could leave my son (I have an IRA and other assets I hope not to have to touch). My pension will cease when I die.

Answer: You could have started receiving survivor’s benefits at 60. (Those who are disabled can start survivor’s benefits as early as age 50, or at any age if they’re caring for a minor child or a child who is disabled under Social Security rules.) Since your husband died before he started benefits, your check would be based on what your husband would have received at his full retirement age of 66. If you start benefits before your own full retirement age, however, the survivor’s benefit is permanently reduced.

For many people, starting survivor’s benefits isn’t as bad an idea as starting other benefits early. That’s because survivors can switch to their own work-based benefit any time between age 62 and 70 if that benefit is larger. Starting survivors benefits early can give the survivor’s own work-based benefit a chance to grow.

In your case, however, the survivor’s benefit is all you’re going to get from Social Security. While it may be tempting to take it early and invest it, you’re unlikely to match the return you’d get from simply waiting a few years to start.

Your description of your non-working adult son as “not officially disabled” is a bit baffling. If he has a disability that truly prevents him from working, getting him qualified for government benefits would provide him with income and healthcare that would continue despite whatever happens with you. (You may not want to touch your assets, but that might be necessary if you need long-term care.) If he can work, then getting him launched and self-supporting would be of far greater benefit than hoarding your Social Security checks for him.

Playing it safe could mean losing money

Dear Liz: The certificate of deposit I owned in my Roth IRA recently matured. I’ve put the money into a Roth passbook account until I can figure out what to do with it. I’m a public school teacher and have a 457 deferred compensation plan to which I contribute monthly. I am 57 and will need to work until I am at least 65. What should I do with the money in my Roth?

Answer: As a public school teacher, you probably have a defined benefit pension that will give you a guaranteed monthly check for life once you retire. Depending on how long you’ve taught and where, this pension could cover a substantial portion of your living expenses.

The guaranteed nature of this pension means that you may be able to take more risk with your other investments. That would mean your Roth could be invested in stock mutual funds or exchange-traded funds that offer potential for growth. CDs and other “safe” investments can’t offer that — in fact, your money loses purchasing power since you’re not earning enough interest to even offset inflation.

Since you’re so close to retirement, you should invest a few hundred dollars in a session with a fee-only financial planner who can review your situation and offer personalized advice.

Will your pension hurt your Social Security benefit?

Dear Liz: Could you please address the issue of Social Security for those with pensions? I understand that if you have a pension, you won’t get 100% of the standard monthly Social Security benefit. I believe that this happens even if you only have a defined contribution account. But I’ve never seen this discussed in news reports. Many people are surprised when I tell them this.

Answer: Perhaps they’re surprised because what you’re saying isn’t true.

Defined contribution plans, such as 401(k)s, don’t affect your Social Security benefit at all. Neither do most pensions. The time that a pension might affect your benefit is if you didn’t pay into Social Security while you were earning the pension.

Here’s how the Social Security website puts it: “A pension based on work that is not covered by Social Security (for example, federal civil service and some state or local government agencies, such as police officers and some teachers) may cause the amount of your Social Security benefit to be reduced.”

The reduction can come under one of two provisions. The first, called government pension offset, applies if you get a government pension not covered by Social Security and are eligible for Social Security benefits as a spouse or survivor. The spousal or survivor benefit may be reduced in that case. You can learn more at http://www.socialsecurity.gov/retire2/gpo.htm.

The second provision is the windfall elimination provision, which may reduce your Social Security or retirement benefit if you receive a pension from a job not covered by Social Security. You can learn more at http://www.socialsecurity.gov/retire2/wep.htm.

These provisions were put into place because some people with a pension from a job that didn’t pay into Social Security were getting more Social Security benefits than the system intended. If they worked mainly in the job with the pension, but also had jobs that paid Social Security taxes, their Social Security benefits were often calculated as if they were long-term, low-wage workers. Since Social Security is designed to replace a larger percentage of earnings for low-paid workers — and a smaller percentage for higher-paid workers — these folks wound up with a bigger benefit than their earnings actually justified.